How "Super Angel" Investors Are Reinventing the Startup Economy

Folks in Silicon Valley are fond of attaching friendly, anodyne labels to forces that seem bent on world domination (hello, Facebook). So it's no surprise that the latest group of alleged tech marauders goes by a name that might be better suited to a Japanese cartoon boy band: Beware the super angels!

These crafty interlopers represent a hybrid between the two investing models that have long ruled the normally placid world of startup funding. Super angels raise funds like venture capitalists but invest early like angels and in sums between the two, on average from $250,000 to $500,000. By being smaller, faster, and less demanding of entrepreneurs than VCs, super angels are getting first dibs on the best new ideas. Mint, Digg, and Ustream are three of the prominent super-angel-funded companies with traction.

The established order in Silicon Valley is used to funding disruptive ideas, not getting crushed by them. Many are now spinning dark conspiracy theories about the super-angel cabal and preemptively floating blame that when the startup bubble pops, it'll all be these angels' fault.

This anxiety is likely to prove superinflated. Indeed, by streamlining and downsizing venture capital, super angels may be pushing Silicon Valley toward accepting something that has long been missing in these parts: economic rationality.

For too long, tech funding has operated like a moldering Reno casino. VCs place dozens of million-dollar bets every year and fully expect to lose almost all of them; the strategy is that for every hundred Cuils (a one-time presumed Google killer), one Google-size payout (or a few) will put them in the black.

But treating business funding like roulette often pushes new companies to act unwisely. In order to get acquired or go public to satisfy their VCs, startups raise too much money (Brightcove), expand too quickly (remember Webvan?), and give away products for free (Ning).Over the 10-year period ending this past June, the VC industry "returned" — 4.2%.

Super angels give startups much less money than VCs, but they expect a lot less in return. Typically, they don't take a seat on the startup's board; they take a small stake in the firm and hand over their funds in weeks rather than months. This frees up entrepreneurs to work on building great products rather than worry about satisfying their funders — which, after all, is the only way they'll succeed.

The irony is that even as they bring new cash into the tech world, super angels might actually be helping to deflate an incipient startup bubble. "The reason crap startups got funded in the dotcom era was because there were a lot of crap investors putting money into them," says Paul Graham, a founding partner at the incubator firm Y Combinator. "Nobody expected actual profits. They just wanted to sell it to the next fool."

But super angels — a clubby bunch ruled mainly by veterans of some of the Valley's most successful startups, including Ron Conway (PayPal), Jeff Clavier (Yahoo), and Mike Maples (Twitter) — aren't dumb money. They have little interest in flipping their shares on Nasdaq (that is, to crap investors like you and me). They can make money on much more likely outcomes. In October 2009, for instance, several angels — including the ubiquitous Conway — put a total of $1 million into Hot Potato, a Foursquare-like check-in service. A few months later, Facebook purchased it for a reported $10 million. That may pale in comparison to the billions that Google earned when going public, but it was a remarkable return in such a short time. If super angels can turn several small investments into $10 million to $20 million sales every year, they're poised to do a lot better than VCs.

Does that mean the end of VCs? Graham notes that by exerting competitive pressure, super angels may push VCs to become more agile. The other possibility is that VCs will edge out of the web game and push deeper into industries better suited to their largesse — capital-intensive fields such as biotech, clean energy, and telecom infrastructure. Witness the $1.1 billion poured into 4G pro-vider Clearwire or the $400 mil-lion behind Bloom Energy.

So super angels may aid VCs, investors, and founders? No wonder they're called super.

Illustration by Frank Chimero

A version of this article appeared in the February 2011 issue of Fast Company magazine.

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About 20 years ago, I remember VCs working on much smaller deals than they do today. back then, I could get interest at the $500k level. Today, they won't even go near a deal that low. Something happened in the VC community that has resulted in a negative impact to the startups. It is now easier than ever to bring an idea to market, but the money threshold is just too low to accommodate the VC groups. Eventually something will have to come along and disrupt the existing cycles. I am all for it.